Natural Resources Newsletter Q3 2019

Quarterly Review Q3 2019



Summer's End Brings No Relief For Energy Stocks

Energy stocks reported another disappointing quarterly as oil prices continued their decline. The XLE Energy Select Sector SPDR Fund fell 9.3% over the three months ended September 30, 2019. This compared to a decline of 1.3% for the S&P 500 Index. This is the second consecutive quarter in which the XLE has underperformed the overall market by approximately 8%. As is usually the case, one need only to look at the performance of oil prices to explain the poor stock performance.

Oil prices, as measured by the WTI November 2019 future price, declined 9.3% from $59.14 per barrel to $53.62 per barrel. The path downward, however, was anything but steady. Oil prices rose sharply in June and again in September to levels above $60 per barrel in response to tension in the Persian Gulf. Higher prices were short lived. Both times, oil prices sank $10 per barrel to a level in the low fifties in the three weeks following the rise. Natural gas prices, as measured by Henry Hub November 2019 futures, were essentially flat rising a modest 0.8% from $2.266 per thousand cubic feet (mcf) to $2.283 per mcf. This is not unusual during the summer quarter when there are few heating degree days.

Oil inventories continue to rise with the EIA reporting consolidated oil stocks of approximately 2 million BBLS (as of 9/27), up 1.7% from a year ago. Of note, domestic production rose approximately 15% year over year and net imports fell 33%. The EIA estimates that the United States could become a net exporter of energy in 2020. Rising domestic production, combined with concerns of a global economic slowdown, seem to be having a bigger impact on oil prices than political tension in the Persian Gulf.

The oil future’s curve is relatively flat at prices near current levels. Many energy companies took advantage of the oil price spikes to add to their hedge positions. For those who didn’t, the opportunity has passed. Longer-term oil prices do not show any relief to producers.

The current outlook for the energy sector remains somewhat negative. Companies are under pressure to lower their operating costs to justify production at $50 per barrel prices. Most companies try to limit expenses to a level within their generated cash flow. With prices down, that means cutting back on operating costs and capital expenditures. A prolonged period at prices near or below $50 per barrel could test the liquidity of companies with burdensome debt levels or high operating costs.
We remain cautious regarding energy stocks. We favor companies with low debt levels, high hedge positions and low operating costs.


Mining stocks underperformed the broader market. Mining companies (as measured by the XME) declined 10.3% during the September quarter versus a 1.2% increase in the S&P500 Index. Year-to-date through September 30, the XME was down 2.8%, while the S&P500 Index appreciated 18.7%. During the third quarter, the price of gold increased 3.4%,while silver increased 11.6%. We note the Van Eck Vectors Gold Miners ETF (GDX) was up 4.5% during the third quarter and 26.7% year-to-date through September 30. The gold/silver ratio was 86.0x at the close of the quarter; down from 92.0x at the end of the second quarter.

Precious metals outlook leans on monetary policy and macroeconomic factors. In our view, monetary policy, geopolitical risk and trade, along with concerns about global economic growth and recession fears in the U.S., will drive movements in gold for the remainder of the year. Underscoring concerns about economic growth, an accommodating posture by the U.S. Federal Reserve and other Central Banks may strengthen gold’s appeal.

Base metals linked to economic growth expectations. With respect to base metals, issues around trade and economic growth will continue to influence demand expectations.

Mining stocks offer diversification benefits. In our view, mining stocks are an attractive way to gain exposure to metals given their leverage to strengthening metals prices. Precious metals equities may provide a hedge against volatility in the equity markets and offer diversification benefits.